Offshore substance legislation draws nearer

The European Union last year accused several offshore jurisdictions – the Cayman Islands, Jersey, Guernsey, the Isle of Man, Bermuda and the BVI – of violating the EU’s fair tax criterion, which stipulates that jurisdictions should not facilitate offshore structures that attract profits without real economic activity.

To avoid being placed on a blacklist of countries that are deemed uncooperative in tax matters, the jurisdictions committed in Nov. 2017 to addressing the perceived lack of tax fairness before the end of this year.

Cayman officials have been in constant dialogue with Brussels to determine the exact changes that offshore centers are expected to make in their local legislation to be deemed compliant.

So far, there have been very few details on what would constitute economic substance mainly because for some time EU member states had not agreed on a definition.

When they did, the EU’s guidance was not prescriptive but rather provided a framework.
The governments of Jersey, Guernsey and the Isle of Man were the first to act when they launched a public consultation in August, asking businesses for their views on proposed new legislation that will require certain tax-resident companies to demonstrate they have sufficient substance.

The three jurisdictions have collaborated in developing proposals that will require companies that are tax resident, and engaged in key activities identified by the EU, to demonstrate that they meet minimum substance requirements as part of their annual tax return.

The key activities identified by the European Commission’s Code of Conduct Group are: banking, insurance, fund management, financing and leasing, shipping, intellectual property, collective investment vehicles and holding companies that generate income from any of these key activities.

The substance requirements vary for each key activity to reflect the different needs of the companies involved.

Under the proposed legislation, companies generally have to demonstrate that the board of directors meets at certain intervals in the respective jurisdictions with a quorum of directors being physically present. The board of directors as a whole must have the necessary knowledge and expertise to discharge their duties as a board.

Strategic decisions must be made at the board meetings and reflected in the minutes of the meeting. Minutes and other company records must be kept in the jurisdiction.

In addition, companies have to ensure that core revenue-generating activities are carried out locally.

The core revenue-generating activities will be defined for each sector in the respective legislation, but the consultation documents noted certain elements.

For instance for fund management, the activities include taking decisions on the holding and selling of investments; calculating risks and reserves; taking decisions on currency, interest fluctuations and/or hedging positions; and preparing relevant regulatory and other reports for government authorities and investors.

If a business functions as the headquarter of a group, all relevant management decisions must be taken there, and group activities must be coordinated or expenses incurred on behalf of group entities to demonstrate core activities.

Holding companies, which purely hold equities, will need to confirm they meet all applicable corporate law and tax-filing requirements.

In addition, all companies that carry out relevant activities must be able to show that they have an adequate level of qualified employees in the relevant jurisdiction, as well as adequate physical office space and expenditures or corresponding outsourced activities in the jurisdiction.

Collective investment vehicles, however, should have reduced substance requirements in line with the local regulatory framework.

Tax resident companies that generate income from intellectual property will be required to show that they are managed in the jurisdiction and undertake income-generating activities like research and development, marketing, branding, distribution, risk management or other underlying trading activities to demonstrate sufficient substance.

How onerous these requirements are remains to be seen. It is also not certain how flexible the rules are for companies that outsource certain core activities to service providers outside of the relevant jurisdiction.

Cayman, meanwhile, has formed several working groups to review the EU’s guidance and provide input into legislative proposals to address the economic substance requirements.
In July, the Cayman government announced that it plans to consult the general public on the matter in due course.

Cayman’s credit rating confirmed

Rating agency Moody’s reaffirmed the Cayman Islands’ Aa3 government bond rating.
The rating, which applies to all bonds issued by the government, regardless of the currency, remains in the top tier of Moody’s rating matrix, three notches below the highest possible rating.

In its annual credit analysis, Moody’s noted that even though Cayman’s economy continues to be highly dependent on financial services and tourism, “the potential cruise terminal project and Cayman Enterprise and Health Cities could boost growth and help diversify the economic base in the medium to long term.”

Moody’s found that Cayman is wealthier and growing faster than other countries with the same credit rating but warned that the economy will slow marginally as large construction projects near completion.

Nevertheless, the rating agency expects tourism projects and infrastructure investments to continue to support the economy.

The rating report highlighted specifically the expansion of the Owen Roberts International Airport, the residences of Health City Cayman Islands, the construction of the 350-room Grand Hyatt Hotel and Residences, and a new cruise terminal in George Town.

Despite Cayman’s susceptibility to hurricanes, the overall risk profile is low, according to Moody’s, as a result of a strong institutional framework, fiscal oversight by the U.K. and low political risk.

The relative wealth of Cayman provides a strong buffer against weather-related shocks as evidenced by Hurricane Ivan in 2004, the report said.

Even though the storm inflicted damage equivalent to 200 percent of GDP, the country was able to recover quickly.

However, long-term economic risks from the loss of competitiveness in tourism or financial services could affect government finances, the rating agency noted.

Unemployment drops to pre-crisis level

Unemployment in the Cayman Islands has dropped to levels last seen before the financial crisis.

Estimates by the Economics and Statistics Office show the unemployment rate was 3.4 percent in April 2018, the lowest since 2007 when the rate stood at 3.0 percent. The unemployment rate was also significantly lower than the 4.1 percent seen a year earlier in spring 2017.

The figures were part of the Spring 2018 Labour Force Survey, carried out in April and May, which showed that unemployment among Caymanians had declined to a rate of 5.3 percent, compared to 6.2 percent in 2017.

Cayman’s economy has seen a consistent downward trend in Caymanian unemployment since it reached a peak of 10.5 percent in 2012.

The unemployment rate among permanent residents with the right to work fell from 4.8 percent in spring 2017 to 2.9 percent, and that among non-Caymanians from 1.7 percent to 1.3 percent.

The fall in unemployment coincided with a 1.5 percent rise in the total labor force.
According to the estimates, Cayman’s economy employed approximately 42,700 people in April. This is about 2.3 percent more than at the same time in 2017.

The Labour Force Survey estimates that, as of June 2018, Cayman’s population has reached 64,240, about 2.1 percent higher than 12 months earlier.

Despite the figures, Premier Alden McLaughlin said, government must do more to deliver on its commitment to full Caymanian employment.

He said red tape, inefficiencies and ministerial misalignments in the past had prompted the creation of the new Workforce Opportunities and Residency Cayman (WORC) Department, which is due to launch in the coming year.

One of the improvements expected from this initiative is a new government function that will work with key private sector employers to plan for the long-term labor market needs of the economy.

Economy grows faster

The fall in unemployment followed a period of stronger than anticipated growth in 2017.
Gross domestic product grew by 2.9 percent in real terms following similar growth of 3 percent in 2016 and 3.1 percent in 2015.

The economic expansion was significantly higher than previous forecasts of 2.1 and 2.4 percent throughout last year.

The construction industry and tourism were the main drivers of the economy last year.
Construction activity, which showed growth of 7.2 percent, dropped off slightly after even stronger growth years in 2016 (7.6 percent) and 2015 (7.9 percent), but this was due to the completion of the Kimpton Seafire resort in late 2016.

Still, construction activity saw a $800 million-record high of project approvals.

Meanwhile, tourist arrivals reached 2.15 million visitors last year as Cayman benefited from the misfortune of other holiday destinations in the Caribbean that were forced to close after they were hit by hurricanes Irma and Maria.

As a result, tourist arrivals in Cayman were 2.4 percent higher than in 2016 and stay-over tourism increased by more than 8.5 percent, especially coming from the U.S. and Canada.
Tourism-related services such as hotels, restaurants and bars also showed a combined growth of 8.5 percent during the year.

The financial services industry, which includes banking and insurance and makes up 41 percent of the economy, grew 1.4 percent, partly due to the low demand for domestic credit by the public and private sector.

Combined with professional services, such as corporate registration, legal and accounting services, which are largely finance-related but classified separately under international statistical standards, the finance sector in Cayman contributes more than half of the economy – 55.6 percent of GDP.

The professional services sector grew by 3.6 percent last year.

The economy is projected to grow by 3 percent in 2018, 2.7 percent in 2019 and 2.2 percent in 2020.

The slight downward trajectory is a reflection of growth forecasts by the International Monetary Fund for the U.S. and other advanced economies that Cayman relies on.

Optimism for the economy is mainly based on the continued strong performance of the construction sector, with many tourist accommodation and residential projects already well under way.

However, two key challenges remain and could put economic projections in jeopardy.

Firstly, the threat of instituting a public register of beneficial ownership in Cayman through an order in council could have an effect. For the time being, government must wait until an order in council is made before it can challenge it. This is unlikely to happen before the year 2020.

In the meantime, government will consult with its legal advisers about the necessary steps, involving judicial review and a potential appeal, should it be necessary.

The second key challenge is the ongoing risk that Cayman may still be placed on the EU blacklist of non-cooperative countries in tax matters, which could attract punitive measures.

To avoid such a blacklisting, Cayman has committed to resolve any issues concerning a lack of economic substance among Cayman-registered entities, identified by the EU.

Cayman remains top center for offshore M&A deals

The Cayman Islands saw more mergers and acquisition transactions than any other offshore jurisdiction in the first half of 2018, as the total value of Cayman deals increased by nearly 50 percent over the second half of 2017.

However, Cayman mirrored other offshore centers with a slight drop in the volume and an increase in transaction value, according to a report by offshore law firm Appleby.

Cayman-incorporated companies were the target of 421 transactions worth a combined US$60.9 billion in the first half of 2018. This represented 31 percent of all offshore deals and 28 percent of total offshore deal value during that time.

Transactions were down 9 percent from the second half of 2017, while deal value was up 49 percent. The higher deal value is caused by Cayman being the home to four of the 10 largest offshore deals in the first six months of the year.

A total of 1,344 offshore M&A deals recorded in the first half of 2018 equated to a 10-percent decline compared to the last six months of 2017. However, the total deal value of $216 billion marked a 68-percent jump over the second half of last year.

It was driven in part by the $62 billion acquisition of Jersey-incorporated Shire PLC by Japan’s Takeda Pharmaceutical. Each of the offshore region’s 10 biggest deals was worth more than $2 billion.

In terms of deal activity, Cayman was followed by Hong Kong (334 deals), the British Virgin Islands (236 deals) and Bermuda (146 deals). Jersey was the offshore leader in terms of total value in the first half of 2018 as a result of the Shire PLC acquisition, Appleby’s Offshore-i report noted.

Meanwhile, the record activity around offshore IPOs in 2017 continued in 2018, with 180 companies announcing their intention to go public in the first half of the year. Offshore IPOs typically occur on U.S., London or Hong Kong stock exchanges, with Hong Kong being an especially popular choice for the Cayman Islands. Cayman is by far the busiest jurisdiction for IPOs involving offshore companies, as 71 of the 80 IPOs completed in the first half of 2018 involved Cayman entities.

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Michael Klein
Michael Klein Editor Pinnacle Media Group Ltd. PO Box 1365, Grand Cayman, KY1-1108, Cayman Islands T: 345-326-1720C: 345-815-0064 E: [email protected] Michael is a financial journalist and copywriter.  In the past he has been responsible for the Risk Management and Corporate Finance sections of a British monthly Corporate Treasury publication.  He has written various financial handbooks, notably on European Banking and Cash Management and the Debt Capital Markets.   In addition he has worked as a copywriter for banks and investment funds and served as corporate communications consultant to US and European blue chip companies.   Michael holds an MA in Political Science and International Law from the University of Bonn in Germany. 

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